The Pharmaceutical/Life Sciences Industries are undergoing a profound change. As the business goes more towards a bottom line management focus, savings from consulting, outsourcing (globalization) and outside technical services become more important. This Blog is focused on serving the interests of those industry clients, investors and their suppliers. We will discuss issues related to the politics, finance and technology and their impact on the industry.

Monday, December 31, 2007

How real is the labor turnover problem in offshore centers? Here’s a question that can turn a meeting about potentially offshoring a company’s processes into a real slugfest. Proponents of offshoring will argue that turnover is no better or worse than here in the United States or Western Europe. Critics will counter that staff turnover rates are a hidden cost of outsourcing both financially and from a customer service perspective. Something is definitely lurking out there.Reuters recently reported that a major Indian outsourcing firm had over 90 per cent turnover in its business services. Apparently, major Indian firms have agreed not to steal each other’s employees. (Interesting, imagine doing that in this country. Possibly another example of American and European firms outsourcing to places where neither legal nor public opinion constraints prevent practices that cannot be allowed in their own countries. But, enough of that, I’ll save it for a separate blog entry.) Anecdotal evidence makes the rounds of wage costs slowly rising in offshore markets as more work comes in than can be readily absorbed and workers are attracted to higher wages.Labor turnover is definitely becoming a bigger probelm in the offshore markets and will continue to do so. There is only a limited amount of capacity available outside of the United States and Western Europe to handle the potential demand for these services. Not to say that this demand can’t be met but it will be expensive. And, it will take time. Just because someone graduates from a university with an engineering degree and English language capability doesn’t mean that he or she is ready to step up to the increasingly higher expectations of the global outsourcing marketplace. Companies that want to meet these expectations now are going to have to hire people with experience from other companies. They may even have to turn to their own countries’ diasporas. There have been mentions in the press over the years of people returning to ancestral homes like Ireland and Korea to pursue new opportunities.How do these companies begin to differentiate themselves? That’s a good question. The large players with strong technical reputations like Microsoft and IBM can differentiate themselves readily. Other large players whether they are home grown like Wipro or Tata will be able to offer diverse opportunities and advancement to potential employees. All of these firms may not feel the need to overpay and find that the “best and the brightest” are naturally attracted to them. However, other players whether they are pure outsourcing plays or captives of foreign companies will find themselves having to continually raise their wage offerings to attract and keep the types and numbers of people that they need. Of course, this leads us back to the original premise of why to offshore in the first place. The major reason for offshoring has been cost reduction. If wages continue to rise through competitive pressures then why offshore? Will offshoring by American and Western European companies continue as it has been going or will it become simply another tool to be used by global corporations in managing their global portfolios of business activities.

Thursday, December 20, 2007

In the last two weeks Biogen-Idec (BIIB) and Genzyme (two of the largest independent Biotechnology Companies in the World) had their respective CEO's announce that they will stay independent, albeit for different reasons. Could this mark the watershed moment that suggests that Big Pharmaceutical Companies will indeed NOT pay any price to buy up companies with attractive pipelines and productsIs it equally possible that these two transactions are anomalies with special circumstances surrounding them?It may be a bit presumptuous to reach the conclusion that acquisitions may have peaked with AstraZeneca paying $15.6 billion for MedImmune in April and Schering-Plough's acquisition of Organon Biosciences BV for $14.4 billion a month earlier (especially noteworthy since Schering's CEO Fred Hassan had publicly stated that acquisition pricing had become "breathtaking"). One could further point to numerous sub or near billion dollar acquisition of smaller biotech companies and technologies (e.g. RNAi) by bigger players such as Pfizer, Merck, J&J among others.My thesis is that senior pharmaceutical executives recognize that they may not be able to buy their way to more success in their business. There is a lot of "low hanging fruit" they need to continue to address including bureaucratic, inefficient R&D; bloated sales and marketing forces having less and less impact on their target constituencies; and excess manufacturing capacity resulting from past tax incentives and mergers. There is clear cut evidence that the mega mergers of the past have done little to enhance shareholder value and that many of the smaller biotechnology acquisitions and/or licensing deals have not produced the promised results.Thus, is there is reduced incentive to buy companies such as Biogen-Idec or Genzyme. The noted investor Carl Icahn bought 1% of BIIB stock earlier this year, increased his stake to 3% quickly, announced that the company was vastly undervalued, driving the stock price up by 50% and forcing management to shop the company. Rumors abounded about interest by Pfizer and Schering Plough among several others, but in the end NO ONE bid for the company and the shares fell over 25%. While Mr. Icahn benefited handsomely form this deal, one could imagine that BIIB's management were greatly distracted and taken away from their duties resulting in lost opportunities for no valued result. The major lesson learned from the acquisition side is that Pharmaceutical Business Development executives will not (and should not) pay any price asked for a deal.In the case of Genzyme, Henry Termeer the CEO is faced with similar circumstances from the same billionaire investor, Carl Icahn. He will likely apply the same pressure tactics to sell the company. Termeer has seemingly intentionally made a strong case that his company's value is too rich (nearly $20 billion market cap), that he doesn't need a partner since he is in a highly specialized area with good vertical integration and finally that his product set of highly specialized, expensive near-orphan like drugs don't lend themselves to the culture of a big pharmaceutical company. Time will tell whether Temeer's strategy will be viable.In the meanwhile we are in for some interesting times!

Wednesday, December 12, 2007

When one thinks about the money invested by the Life Sciences industry in the services business to improve its processes (likely over $100 billion over the last 10 years; my estimate basis is in excess of $5-10 billion per year predicated on a spend on services equal to 1-2% of yearly worldwide revenues), it is reasonable and of concern that the value and results achieved fall far short of expectations. My challenge is to question how to improve the value received by our clients based on measurable results to date. The evidence suggests our clients are at a crossroads and their ROI and trust in our advice, products and services has not served them well.

Witness a recent article in the Wall Street Journal (12/7/07) that points out that over the next few years, the pharmaceutical business will hit a wall. It states that "Some of the top-selling drugs in industry history will become history as patent protections expire, allowing generics to rush in at much-lower prices. Generic competition is expected to wipe $67 billion from top companies' annual U.S. sales between 2007 and 2012 as more than three dozen drugs lose patent protection. That is roughly half of the companies' combined 2007 U.S. Sales. At the same time, the industry's science engine has stalled." Where are the benefits of all the improvement projects undertaken? Was this crisis unavoidable or could have the "consultants" provided "better vision"?

One particularly challenging issue is that R&D productivity has decreased by 50-75% over the last several years (based on the number of new NCE's approved as a function of R&D spend). The WSJ article further suggests that "during the five years from 2002 through 2006, the industry brought to market 43% fewer new chemical-based drugs than in the last five years of the 1990s, despite more than doubling research-and-development spending.". Combine this with a glut of new sales and marketing initiatives and resources that are yielding at optimistic best little return; significant overcapacity in manufacturing capacity and an overall bloated SG&A component of the balance sheet, management and its advisors should think about a different way of doing their business.

Lest we think that the gurus of Wall Street and other worldwide bourses haven't noticed, valuations of pharmaceutical shares, once considered safe havens worthy of a Price/Earnings premium to the rest of the stock market have witnessed a valuation decrease of nearly 20% while in the last 5 years while the overall market has gained nearly 75%!!! Of further concern is that Moody's Investment Services recently lowered the rating of Pharmaceutical Industry debt to negative (not far from the Sub-prime debt that has caused worldwide turmoil).

My suggestion is that while there are numerous external forces at work and many potential issues to address, it would behoove our brethren in the advice giving industry to think more out of the box and create a win-win situation to help our key clients. Your thoughts are invited.

Saturday, December 1, 2007

Is there a healthcare crisis in America? Boy, now there’s a question to quickly divide the old cocktail party between the liberals and the conservatives. While I feel there is a certain amount hyperbole from both camps, I will come out early and say that something is amiss out there. Also, some of the solutions that are bandied about may not be as practical as hoped or scalable to the size of the American problem. Why do I suggest that there is problem with US healthcare. First, the availability of affordable healthcare insurance is becoming a major concern across the country and will undoubtedly be a significant issue in the upcoming Presidential election. I personally have learned firsthand of this through the misfortune of several friends of mine, who when recently downsized from their jobs found their severance packages inadequate for their COBRA payments and had to use their savings sooner than planned. Tens of millions of Americans don’t have healthcare insurance. Emergency rooms across the country are swamped with sick people without coverage who they cannot turn away because of local legislation. The problem is dealt with by closing hospitals and stopping certain services. Not a particularly effective approach for maintaining public health. Also, don’t think for a moment that this won’t be a big part of the impending national debate over illegal immigration. OK, we’ve talked about the demand side and its increasing costs. Now, let’s talk about the supply side, let’s start with doctors. I can remember growing up in a major American city in the Sixites that doctors made good money, had the best house in the neighborhood, and drove the biggest car. I don’t find that with many young doctors today. My primary care physician recently told me that he’s earning about sixty percent of what he thought that he would be because the insurance companies haven’t kept up with inflation. He said that some of the providers hadn’t updated their reimbursement tables since the Eighties. Now, he’s a general practitioner who says that he’s very happy with his practice otherwise. He’s doing what he loves. I won’t pretend that this is a scientific survey but I don’t get the feeling that the ordinary doctors and dentists we meet everyday are the cause of the surge in healthcare costs. He doesn’t even complain about his malpractice insurance costs, although he does say that certain specialties are being priced out of his state. Another component of the demand equation are the hospitals. But, again, the evidence doesn’t seem to support this. Hospitals are going under and are struggling to pay their bills. Also, several have begun to use some pretty heavy handed collection agencies to collect from their indigent patients. Now, a case can probably be made that hospitals haven’t been the most efficient organizations but this has been gradually changing. Next up on the demand side are the pharmaceutical, medical device, and other suppliers whose products both the doctors and hospitals use. There’s probably a case that these have been making excessive profits by comparison to their customers, but, as has been written elsewhere in this blog, this will probably begin to change soon. While their prices and practices may have contributed to the run up in healthcare costs, I haven’t seen any evidence that lays the blame solely at their doors. The last part of the demand equation I’ll write about are the health insurance providers. No one seems to like them. Patients, their doctors and hospitals, and the employers who provide their service to their employees do not like them. Politicians of all political stripes seem to feel that they are fair game as do late night talk show hosts. The last group of people that I can recall being this generally disliked were Saddam Hussein and his sons and look what that got them. But, let’s also not forget what we’ve had to live with once they were taken out. No simple solutions here. So, something’s wrong here. No one seems to be very happy about the current situation especially those who depend on it either for their wellbeing or their livelihood. (I would be interested to know if Senator Bob Dole still thinks everything is fine but I don’t know how to contact him.) People talk about the Canadian system but their drug prices are only low because of their beggar thy neighbor policy that foists the costs of US drug research and development back onto their southern neighbors. France has been recently mentioned in the media for a successful system but haven’t French workers been striking lately about proposed cutbacks in their benefits? And, I won’t waste any more space over the failure of public healthcare under the Communist regimes in Russia and China. I wish that I could propose a simple, easy and affordable solution that everyone would jump up and immediately agree with. I’m sorry, I can’t. I’m not that smart. Sometimes I wonder if anyone is. But, I do know this, if we don’t develop the national will and resolve to deal with this issue, whether or not it’s a full blown crisis now or only later, then somewhere down the road both for the public at large and the healthcare industry there will be very serious consequences.

Are US based nearshored outsourcing centers cost competitive with India? Now that the initial hysteria over all our jobs going away to India, or wherever else they were going to go, is over, is this the time to discuss the possible use of other US sites to gain competitive advantage? There are two sets of variables in these types of decisions, objective and subjective. Let’s use classical economics factors of production to begin our review. We’ll start with land. While most overseas locations that are considered for outsourcing have plenty of land, do they have the infrastructure that goes with it? Also, and let’s be honest here, American and European businesses were taking advantage of the, until recently, lax environmental and OSHA-like regulations in these locations. Buildings with the necessary fixtures to support global businesses, communications infrastructure, power grid, and public transport for workers are all required. The earlier locations, Mumbai and Shanghai, have been built out and are expensive. The second tiers are being identified and are being moved to. However, how smooth this transition will be remains to be seen. While major American cities like New York and Los Angeles are still expensive, sites in the Midwest (South Dakota) and the Southeast (Mississippi) offer promising alternatives. As businesses begin to find the true costs of building overseas and the increasing regulatory environment (or, are held accountable by public opinion for seeking out locations without these protections), local sites should begin to see interest. And, these locations are not shy about promoting themselves. Michigan has been very aggressive in getting its message out across the country lately. Next is labor. By now, most people have probably heard about the rapidly increasing wage costs for staff with the appropriate language and technical skills and the high staff turnover resulting for those that don’t keep up. The media has reported stories of call centers that probably compromised on their hiring standards and have had bad customer experiences when they couldn’t understand the operators. Obviously, this topic is a very sensitive one. But, as with land, labor offers potential in this country particularly as US corporations begin to shed themselves of expensive health insurance and pension plans. Costs are rising offshore and regional costs in this country are starting to look somewhat appealing. Some US companies are beginning to place centers at locations near state university systems away from major metropolitan areas. Finally, capital. The overseas locations are still not as efficient as the US. Sometimes, it’s the simple things like the low rate of adoption of credit cards in these markets. Payment systems while improving are still not at US and European levels. Then there’s the foreign exchange issue. Then there’s the long term question about the tax policies of the countries where these facilities are located. Will they see this as an opportunity for revenues when their overheated economies begin to cool down? OK, those were the quantitative. And, while I don’t think anyone is going to rush out and throw out their current offshoring plans, the points mentioned are intended to help thinking about future trends, challenges, and opportunities. Let’s review some subjective considerations. Admittedly, these by there their nature cannot be measured and do have a somewhat emotional aspect to them. But, they shouldn’t be dismissed too lightly. Let’s group them around the three criteria that we’ve just used. First, land. Many of these places are a long way to go. As the second tier cities are used that’s even more distance to go on the ground which is why those roads and public transportation are so important. Also, physical security becomes more important the further you go form the main cities. Then there’s the political/economic risk associated with these locations. Next, there’s labor. Language and culture are very important considerations. The quality of education becomes very important. People are people. If their government is unhappy with our government then they may become happy with us. In a dictatorship like the People’s Republic of China that’s a very real possibility. Finally, we have capital. Nationalization and market risks are some of the possible difficulties here. The point here is that businesses shouldn’t be putting too many of their eggs in any one basket. I haven’t been trying to dismiss offshoring out of hand because I believe that it has a place in the regional strategies for global companies. I just want to lay out for discussion some factors that could change in the not too distant future. The current business environment is in a state of flux and I think that earlier choices that have fallen from favor may come back into consideration soon.

How will public healthcare reimbursement affect drug research and development? With an aging population looking to Medicare for assistance the American Federal government is looking at a chronic spending increases well into the twenty-first century. The recent enormous Federal budget deficits cannot last. The latest freefall of the US dollar in the currency markets won’t permit this. The other usual tools of fiscal policy, tax increases and spending cutbacks may not be as effective as they once were because of electoral resistance. Logically, we’re led back to the spend itself.There are two aspects of the current US government’s spending for healthcare, also including the various states and local municipalities, which could come under scrutiny. First, current Federal legislation prohibits Medicare from negotiating pricing discounts based on volume. (Which has led some wits to wonder why when corporations use their purchasing volume to lower prices it’s capitalism, but, when the governments do it, it’s Communism.) This goes beyond the usual debate over generics and non-generics. Even generics would be considerably cheaper if Medicare were to seek volume discounts. Next, the nature of prescription drugs could be open to government scrutiny. Drug companies have been coming under criticism in the popular press for their tendency for the last several years to treat the symptoms of chronic illnesses rather than actually curing anything. How many people do we all know who are taking statins for chlolesteroel and have been told by their physicians that they will probably stay on these drugs for the rest of their lives? In addition, some public healthcare systems like the United Kingdom are only willing to reimburse for drugs based on their effectiveness. While these approaches might not significantly reduce the cash outflow to the drug companies assuming the savings would be used to either hold costs down or to purchase additional product, they could be faced with pressure on their profit margins.Faced with aggressive purchasing authorities at Medicare, the drug companies will have to re-look at their costs and investments as they struggle to maintain their earnings and meet Wall Street’s expectations. Drug research and development could be the first target of opportunity. Significant sums are spent here every year by the world’s pharmaceutical companies and not all research leads to a successful drug let alone a blockbuster. Add to this the risk that the treatment might not be approved by government watchdogs and the drug businesses might decide not to take certain risks. So, short term, everybody’s happy, right?Not so fast. Medicare and drug company senior management might be happy, but, investors shouldn’t be. The industry’s future product pipeline is already under pressure. Reductions in spend, shutting down of facilities, and laying off of research personnel would not do anything to help here. We would see consolidation around the few companies that are true thought leaders in research and development and have the funds to purchase assets that might be available for something less than the premiums that they once carried. As the US Presidential election draws closer in November, investors should be thinking about the implications for the drug companies. A strong showing for the Democrats could lead to changes in public policy in purchasing drugs which will continue the trends in the industry that this blog has been writing about.

Offshoring: too late for labor arbitrage? The recent near panic in the American media over the loss of jobs overseas, reminiscent of the dot-com hysteria about tearing down all the buildings and all of us working from home, overlooks the simple fact that original conditions change and change quickly. The original assumption behind offshoring was reduced expenses arising from exploiting lower wage societies and when English was a first or strong second language, so much the better. Early starts were in Ireland, India, and China. Initially, manufacturing processes went and then services began with the advent of improved technologies. However, what happens when everyone goes the same route, and not only in the US, but Europe and Japan begin to follow? And, then let’s not forget the developing economies in India and China with their own needs. Labor rates have been increasing in countries such as India that have led to significant staff turnover there. The old joke about nobody quits their job for a nickel more an hour isn’t true in Mumbai. Ireland, once notorious in Europe for high, persistent unemployment, now has full employment. Furthermore, as businesses continue to chase labor arbitrage across the globe, what happens then? Firms moving across Europe are moving into eastern Europe and Russia. From the East, it’s the Philippines, China, and India. Where will these movements come together, Kyrgyzstan? And, then what? There’s no place left to go. Putting aside the political/security considerations for a moment, when the labor arbitrage game is played out, how will potential offshore centers differentiate themselves? Here’s where we go back to those annoying political/security considerations. The recent political emergency in Pakistan, no wait, let’s be accurate, the latest manifestation of the political emergency in Pakistan potentially destabilizes a nuclear armed military dictatorship which borders America’s favorite offshore location. Other potential offshore locations, the Philippines and Brazil, have chronic security problems. Even China has significant internal problems in its interior away from the prosperous coastal regions. Other factors are different time zones, language and cultural differences. Anyone who has tried to fly in and out of the Mumbai international airport lately knows what I’m talking about. Other factors such as real estate costs are still relatively expensive. What I’m suggesting here is that, shortly, labor arbitrage, while remaining a consideration in the future, will no longer take precedence. Like all other fads, whether they are the Internet or tulip bulbs, it will run its course and burn out. Offshoring for pure labor arbitrage, especially places far, far away will run its course too. While it will always be a component in business strategy, it will no longer have precedence over other more traditional business drivers. The restructuring that has been underway in American business will ultimately make its wage base more competitive when other factors are taken into consideration. Future outsourcing arrangements should take this point into consideration when being negotiated. Regional offshoring will make sense for multinationals with a truly global presence. However, simply sweeping all US based operations offshore in the hopes of saving money doesn’t seem to make much sense for much longer.

Is there excess capacity in the pharmaceutical industry? The last several decades in the United States has seen other industries, steel, banking, automobiles, personal computers, and airlines, to name but a few that have seen consolidation and shake out. Is it the pharmaceutical industry’s turn? What were the signs in those industries? Stagnating revenues and growth, bloated organizational and cost structures, overbuilt manufacturing capacity, and lack of new product development and innovation were signs in some if not all of those industries. All of this evidenced by stock prices that languished in a narrow trading range for an extended period punctuated by rapid drops when earnings failed to meet the markets’ expectations or there were losses. Which brings us back to pharmaceuticals. The last several years have seen all of these in the pharmaceutical sector with a few additional problems that are unique to it such as FDA regulations and third party health insurer payment policies. While the industry has been spared the high profile bankruptcies of recent years, declining revenues, increasing compliance costs such as Sarbanes-Oxley, bidding wars for boutique biotech and non-core businesses such as medical device firms (anyone still remember Guidant?), and product liability costs ($4.5 billion at Merck in November 2007) could change this shortly. So, let’s ask the original question again, is there excess capacity in the pharmaceutical industry? Recent announcements of cost cutting efforts and layoffs seem to evidence this. The media’s recent spate of articles about the faltering new product pipeline raises the question of what’s happening at all those expensive research and development centers. The already mentioned bidding wars for start up biotech firms seems to hint that senior pharmaceutical management want to hedge their internal investment efforts. Pharma’s move of expensive research centers to offshore locations in China and India could make one think that these are more commodities than business differentiators. Federal government and third party health insurers increasing reluctance to pay for new drugs and procedures could mean a limited pool of dollars being available for new drugs. Overseas, the United Kingdom is beginning to pay for drugs based on their efficacy. At what point will the industry begin to understand what that pool is and scale back their facilities? At what point will we begin to see an increased level of mergers and acquisitions among the global pharma companies? Will the falling US dollar bring a rash of foreign takeovers of US firms? Maybe an industry that liked to boast that it was different from other industries (where have we heard that before?) isn’t really all that different.

Greetings and welcome to the Lawrence Group’s newly launched blog dedicated to keeping life sciences/pharmaceutical industry executives, their advisors, the investment community, and the media up to date on newly developing industry ideas and trends before they break out into the mainstream. I intend to invite industry participants and interested parties to contribute and share their ideas and opinions with us while initiating discussion about these.The life sciences/pharmaceutical industry is entering a new and unknown phase in its existence frought with peril, but, also, opportunities. In addition to writing about the industry, my contributors and I will also write about the impact of globalization and the changing US healthcare environment. The coming US Presidential election should provide excellent material for commentary.My recent retirement from a large, global consulting services firm now gives me the luxury to explore topics in a way with people that I couldn’t while I was employed in industry and I’m hoping to bring some edgy and thought provoking commentary by thought leaders in the industry. The benefits of regularly reading this blog would be access to topics of relevant interest by other industry thought leaders, exposure to a large number of hits by other readers, and a ready made forum to easily publish their ideas.I look forward to providing my friends and colleagues with a valuable source of industry comment and invite their comments and submissions as registered users.Should anyone have any queries or wish to discuss any aspect of this blog with me I can reached via e-mail at larryrothman@consultant.com.Thank you for visiting my blog and I look forward to hearing from you in the future!